clearing manager financial transmission rights prudential
TRANSCRIPT
Clearing Manager Financial Transmission Rights
Prudential Security Assessment Methodology Review
Consultation on proposed methodology in accordance with the
Electricity Industry Participation Code of 2010
10 April 2012
Author:
Erich Livengood
Steve Torrens
Matthew Steans
Document owner:
Erich Livengood
Version No:
2.0
Date:
10/04/2012
Contents
A. Introduction .............................................................................. 4
B. Scope ...................................................................................... 4
C. Consultation process ..................................................................... 5
D. Background ............................................................................... 6
E. FTR Prudential Security Requirements: Problem definition ........................ 11
F. Current prudential security requirements ........................................... 14
G. Overall treatment of FTR prudential security ........................................ 16
H. Experience in comparable systems ................................................... 19
I. Potential approaches to FTR prudential security assessment ...................... 21
J. Discussion of the merits of the various approaches ................................. 26
K. Draft methodology for on-going assessment of FTRs ............................... 31
L. Draft methodology for initial auction of FTRs ....................................... 35
M. Refinement of the draft methodology ............................................... 38
N. Consultation questions ................................................................ 39
NZX Ltd, 10 April 2012 1
Glossary ASX future prices Prices from the ASX New Zealand electricity futures, option and strips
market.
Daily Settlement Price
(DSP)
The Clearing Manager’s assessment of the Hedge Value of an FTR on
any given day prior to settlement.
EMS Energy Market Services, a business unit of Transpower New Zealand
Limited.
FAP FTR Allocation Plan.
Final FTR Payment The payment due on an FTR after FTR Payment Scaling has been
applied.
Final Prices Final wholesale electricity prices as published by the pricing manager
for every trading period in a day and for every node on the grid.
Expressed in $/MWh to 2 decimal places.
FTR Financial Transmission Right. FTRs are allocated to FTR Participants
(who then also become FTR Holders) in an FTR Auction or through
assignment.
FTR Assignment The assignment of an FTR from one FTR Participant to another, in
accordance with clause 13.248 of the Code.
FTR Assignment Price
per MWh
Price per MWh, if disclosed in accordance with clause 13.249 of the
Code, at which an FTR has been assigned. Expressed in $/MWh to 2
decimal places.
FTR Auction Clearing
Price
Price for each FTR Type and FTR Direction at which an FTR Auction for
a particular FTR Period clears. Expressed in $/MWh to 2 decimal
places.
FTR Acquisition Cost The FTR Acquisition Cost is the amount which an FTR Holder owes
the Clearing Manager for the acquisition of the FTR. Any FTR Hedge
Value is offset against the FTR Acquisition Cost at settlement.
When FTRs are assigned at auction, the FTR Acquisition Cost is
determined from the auction:
Initial FTR Acquisition Cost = FTR contract volume (in MWh) × FTR
Auction Clearing Price (in $ per MWh).
Subsequent assignments will alter the FTR Acquisition Cost where the
FTR Assignment Price is disclosed.
Note: The Code currently uses the term ‘FTR Payment’ in place of
‘FTR Acquisition Cost’. A proposal to revise this term is with the
Authority.
FTR Hedge Value The FTR Hedge Value is defined by the FTR Manager in the FAP for
FTR options and obligations. It depends on the FTR contract volume
(in MWh) and FTR hub differential price difference (in $ per MWh).
FTR Holder An FTR Participants that holds an FTR. Every FTR has an FTR Holder.
FTR Participant A party who has been approved and registered by the FTR Manager
to participate in an FTR auction or to be assigned FTRs
NZX Ltd, 10 April 2012 2
FTR Payment Either Provisional FTR Payment or Final FTR Payment according to the
context.
Note: The Code currently uses the term ‘FTR Payment’ in place of ‘FTR
Acquisition Cost’. A proposal to revise this term is with the Authority.
FTR Payment Scaling The process of scaling down Provisional FTR Payments in cases of
Revenue Inadequacy.
Where there is Revenue Adequacy, there is no FTR Payment Scaling .
FTR Product An FTR of specific FTR Period, FTR Type and FTR Direction.
FTR Rentals Amount The amount calculated by the FTR Manager for a specific FTR Period
in accordance with Schedule 14.6 of the Code, that the Clearing
Manager assigns to the FTR Account and uses for FTR Settlement.
FTR Reserve Value The maximum value the Clearing Manager will apply to an FTR during
or immediately following an auction. The initial (i.e. at auction)
prudential security requirement for an FTR is the difference (if any)
between the Acquisition Cost and the lesser of the FTR Reserve
Value or the Auction Clearing Price. The FTR Reserve Value is
provided by the Clearing Manager to the FTR Manager.
FTR Type An FTR can be either an Obligation FTR or an Option FTR.
Hub Has the same meaning as “hub” under the Code.
Each FTR has a ‘From Hub’ and a ‘To Hub’. For example, for an
Otahuhu to Benmore FTR, the From Hub would be Benmore and the
To Hub would be Otahuhu.
Initial Margin In the example of a derivatives market, the security required by a
clearing house to cover the potential movement in the value of an
instrument prior to the clearing house being able to demand and
receive a Variation Margin payment. Often the amount relates to the
‘worst case ‘one day movement.
Instrument A financial instrument is a tradable asset, evidence of ownership
interest, or contractual right or obligation. Cash instruments are
financial instruments valued directly by markets. Derivative
instruments derive their value from the value and characteristics of
underlying entities.
Margin A Margin is the amount calculated by a clearing house as necessary
to cover the risk of financial loss on an options or futures contract
due to an adverse market movement.
Mark to Market The process by which a position in an instrument is valued with
reference to market price of the underlying physical asset.
Mark to Model The process by which a position in an instrument is valued at a price
determined using a financial model. It is often used in markets with
low liquidity.
Price Setting Trade (PST) Price Setting Trade. Where an FTR has been traded at a price that is
deemed by the Clearing Manager to be reflect the market value of
the FTR.
Provisional FTR Payment The Clearing Manager calculated payment due on an FTR prior to the
application of any FTR Payment Scaling.
NZX Ltd, 10 April 2012 3
Reference Price Refers to a value (of an instrument, commodity, etc) derived from a
market price or a model which is referenced by the Clearing Manager
to adjust the DSP for an FTR when the DSP cannot be set directly
using a Price Setting Trade.
Side Payments Relating
to Assignments
The payments between the Assignor and the Clearing Manager
required for Assignments where there is Disclosed Assignment Price
not equal to the FTR Acquisition Cost pre-assignment.
Side Payment Assignor
to Clearing Manager
In cases of an FTR Assignment with an FTR Disclosed Assignment
Price, then if the FTR Disclosed Assignment Price is less than the FTR
Acquisition Cost, a side payment of the difference is made by the
Assignor to the Clearing Manager.
Variation Margin An increase in prudential security requirements due to an adverse
change in the current value of the FTR.
NZX Ltd, 10 April 2012 4
A. Introduction
The Electricity Authority is implementing a Financial Transmission Rights (FTR) market with
the first auction of FTRs scheduled for October 2012.
FTR Participants can purchase FTRs to hedge locational wholesale price risk or simply for
speculation.
Energy Market Services (EMS) has been appointed as the FTR Manager and is consulting
with the Industry on its draft FTR Allocation Plan (FAP). The EMS consultation document
provides an overview of the FTR market design, the specifications of the make-up of the
FTRs themselves, and the plan for auctioning the FTRs to the market.
NZX, as Clearing Manager, is charged with developing, consulting on, and implementing a
methodology for assessing prudential security requirements for FTRs acquired by FTR
Participants. The Clearing Manager also maintains prudential security accounts, provides
prudential security information to the FTR manager, and settles the FTR market alongside
the spot market.
The Clearing Manager is coordinating closely with the FTR Manager during the stand-up of
the market in order to ensure a successful and efficient implementation for the industry.
B. Scope
Part 14 of the Electricity Industry Participation Code (the Code) provides for the assessment
and management of prudential security by the Clearing Manager. Clause 14.19B of the Code
specifically requires the Clearing Manager to prepare a draft methodology for determining
the minimum level of security required in respect of FTRs, consult on it with market
participants and have the final form of the methodology approved by the Authority.
This document presents the Clearing Manager’s draft prudential security assessment
methodology with respect to the FTR market. This document should be considered
alongside the FAP consultation document released on 10 April 2012. In this document we
seek to avoid duplicating the material introduced in the FAP and concentrate on the
prudential security methodology for the FTR market.
In order to provide the industry context in which to evaluate the proposed methodology,
this document provides:
a. background information on prudential security as it stands now;
b. overall treatment of FTR prudential security;
c. discussion of advantages and disadvantages of potential FTR valuation
methodologies;
d. timing of assessments, calls, and processing of deposits as they relate to the FTR
Manager’s plan and spot market transactions;
e. details of required further development of the draft methodology and information
availability and transparency of that process; and
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f. pros and cons of the proposed approach
C. Consultation process
The Clearing Manager invites participants to submit on the draft methodology presented in
this paper.
Written responses in electronic form are preferred. The consultation period begins on 10
April 2012. Responses should be emailed to [email protected]. If you do not wish to send
your submission electronically, you should send one hard copy of the submission to the
address below.
Postal address
Clearing Manager
c/o NZX Energy
NZX Limited
P.O. Box 2959
Wellington 6140
Physical delivery
Clearing Manager
c/o NZX Energy
NZX Limited
NZX Centre
11 Cable Street, Level 2
Wellington
Responses should be received by 09:00 on 22 May 2012 for full consideration. The Clearing
Manager will acknowledge receipt of all submissions electronically. Please contact the
[email protected] if you do not receive electronic acknowledgement of your submission
within two business days.
Please identify any confidential information. Your submission is likely to be made available
to the general public on the Authority’s website. Submitters should indicate any documents
attached, in support of the submission, in a covering letter and clearly indicate any
information that is provided on a confidential basis.
As required by sub-clause 14.19B(3) of the Code, all information received as part of
submissions will be made available to the Authority. Please note that all information
provided to the Authority is subject to the Official Information Act 1982. Please identify any
information in your submission that you consider commercially sensitive.
A list of questions that the Clearing Manager would like feedback on is provided for in
Section N. Participants are welcome, though, to provide feedback on other areas within the
scope of this paper.
The main points of contact for the consultation process and the subsequent development of
the methodology are as follows:
Process Step Date
LPRTG Meeting 16 March
Initial FAP out to consultation 10 April
Draft Prudential methodology out to consultation 10 April
NZX Ltd, 10 April 2012 6
Workshop - Wellington 2 May1
Submissions due 22 May
D. Background
The specifications for FTRs and the associated auctions are included in the FTR Allocation
plan prepared by the FTR manager. The draft allocation plan is currently under
consultation.2
In this section we describe the participant cash flows associated with FTRs as well as
supporting communications from acquisition to settlement. We also introduce FTR
settlement and side payments—Clearing Manager tasks which are not the subject of this
consultation.
This information is provided in order to assist the reader to understand the overall cash
flows of the FTR market and as background for the draft FTR prudential security assessment
methodology.
The implementation details described in this section are subject to Electricity Authority
approval of changes to the Clearing Manager’s functional specifications.
Cash Flows
The Clearing Manager is charged with assessing wholesale electricity market prudential
requirements and verifying FTR Participants have lodged sufficient prudential security before
purchasing FTRs and at all times FTRs are held. The Clearing Manager is also responsible for
settlement of FTRs. The figure below shows illustrative cash flows between the Clearing
Manager and an FTR Participant for a single FTR. See the FTR Financial Flows section in the
FTR Manager’s draft allocation plan consultation document for additional detail and an excel
model.
1 Tentative date. Check www.nzxgroup.com/energy for updated workshop information.
2 See www.ftr.co.nz
NZX Ltd, 10 April 2012 7
Participant purchases an FTR at auction for price ‘a’. The auction clearing price
becomes the FTR value for prudential purposes and an offsetting obligation
“acquisition price” ‘a’ is recorded. No funds change hands.3
Clearing Manager subsequently assess that the value of the FTR has declined. The
Clearing Manager calls the participant to make up the difference so the market is
covered in case of default. Payment due within three business days.4
Clearing Manager assesses further reduction in value of the FTR triggering another call.
FTR value increases. Surplus funds can be returned to participant upon request.
FTR month is completed and Clearing Manager calculates settlement amount. Clearing
Manager calls participant for difference between the calculated settlement and the
previous assessment. Payment due within three business days.
Participant pays Clearing Manager amount due upon settlement (the FTR Acquisition
Cost less the Hedge Value).
There are three types of payments represented in Figure 1 above: a payment to satisfy a call
from the Clearing Manager, a refund of surplus prudential security to a participant, and a
Final FTR Payment to the Clearing Manager at settlement. A fourth type of payment is a
Final FTR Payment to the participant from the Clearing Manager.
Each of the payments, with the exception of the refund of excess prudential security, is
triggered by the Clearing Manager and communicated using existing channels.
The Clearing Manager issues
• a call notice when additional prudential security is required--participants have three
business days to meet the call,
• an invoice including Final FTR Payments due to the Clearing Manager as a line item,
and
• a pro forma invoice including Final FTR Payments due from the Clearing Manager.
Timing of information flows
3 The participant would have been required to post sufficient prudential security to cover the new
position prior to bidding in the auction. 4 For simplicity, the FTR assessed value is shown to change only eight times in Figure 1. The proposed
frequency of assessment is discussed in Section K.
NZX Ltd, 10 April 2012 8
The timing of the Clearing Manager notices to participants is described in Table 1 below.
The daily provision of FTR Hedge Value, price, and a participant’s exposure through a secure
web portal is a new feature. FTR settlement details are to be provided to participants on
the 5th business day just as hedge settlement details are currently provided to participants
who have hedges lodged with the Clearing Manager. The other communications listed are
currently utilised for the spot market.
Table 1: Timing of information flows to industry
Time Name Method
Daily FTR Hedge Value, price, FTR
Participant exposure
Secure web portal
5th
business day FTR settlement details, Hedge
Value, Acquisition Costs,
scaling
Emailed to designated
addresses, secure web
portal
9th
business day Invoices including net FTR
Payments (final payments)
Emailed to designated
addresses
20th
of the month (if business day) or
next business day (settlement day)
Payment, advice of default or
market notice of default if
required
Payments into designated
accounts, Notices by email
On or after settlement day Buyer created tax invoices Email
Ad hoc – as required up to daily Call notices Email to designated
addresses. Courtesy phone
call to designated contact
Settlement
After the FTR period, the Clearing Manager will calculate the Provisional FTR Payment for
each participant. This value includes the FTR Hedge Value and the FTR Acquisition Cost. The
payment is scaled if the FTR market is not revenue adequate for the month. The payment
for each FTR at settlement, the Provisional FTR Payment net of any scaling, is the Final FTR
Payment. The Final FTR Payment will be invoiced to participants on the 9th business day of
each month.
The Provisional FTR Payment is described in detail in Section C2.7 of the FTR Manager’s Draft
Allocation Plan Consultation Paper. FTR Acquisition Cost is the FTR Acquisition Cost at
auction updated by any assignments with a disclosed Assignment Price.
In the event of default, any payment made by a defaulting participant is prorated between
the participant’s FTR Payment obligations and all other obligations (spot market purchases,
hedge settlement, etc) in accordance with Section 14.48B of the Code. FTR associated
payments from the Clearing Manager are pro rated to the extent of any shortage. This pro
rating is accomplished by recalculating the scaling factor prescribed in Section 14.47A of the
Code.
Any payments due to the Clearing Manager associated with the settlement of the FTR are
due by 2:00 pm on settlement day along with spot market payments. Any amounts due to
the FTR Participant from Clearing Manager are initiated in same day cleared funds payment
by 4:30 pm on settlement day. FTR Payments are not netted and an FTR Holder may both
pay to and receive payment from the Clearing Manager on settlement day. For example if
the participant holds a BEN-OTA obligation FTR and a OTA-BEN option FTR, and the
NZX Ltd, 10 April 2012 9
participant is to receive a payment on the BEN-OTA obligation but must pay the clearing
manager for the OTA-BEN option FTR, the participant must pay the full amount due for the
OTA-BEN option into the Clearing Manager’s account by 2pm.
Scaling of payments
The Clearing Manager is required to scale payments5 where the sum of Provisional FTR
Payments and Side Payments Clearing Manager to FTR Holder exceeds the total amount
expected to be available from the FTR account to make payments.
The total amount available is, for each FTR month, the sum of:
• the FTR Rentals Amount (a portion of loss, constraint, and reserve rentals, as
determined by the FTR manager),
• anticipated FTR Payments from participants to the Clearing Manager, and
• any payments to be received from assignors as a result of an assignment (Side
Payments FTR Holder to the Clearing Manager).
The Clearing Manager scales all Provisional FTR Payments and Side Payments Clearing
Manager to FTR Holder to the extent required, given the available funds. Payments owed to
the Clearing Manager are not scaled.
Scaling is detailed in the Final FTR Payment Section (C2.9) of the FTR Manager’s Draft
Allocation Plan Consultation Paper.
Side Payments associated with assignments
When an FTR Participant secures an FTR at auction, that participant becomes obligated to
pay the auction price, the FTR Acquisition Cost, to the Clearing Manager. The FTR
Acquisition Cost is netted against any Hedge Value when invoiced. Because the FTR
Acquisition Cost is not related to the Hedge Value, an FTR’s Acquisition Cost is associated
with each FTR.
An FTR may also be transferred, or assigned, between FTR Participants outside of the
auction process. Where an FTR is assigned the price may be disclosed or not disclosed.
If price is disclosed, the FTR Acquisition Cost associated with the FTR is updated so that the
assignee is responsible for the updated cost on settlement day. If no price is disclosed, the
assignee becomes responsible for the existing FTR Acquisition Cost.
While a price may be disclosed when an FTR is assigned, there is no requirement in the Code
for that price to represent either party’s view of the value of the FTR and there is no explicit
prohibition on side payments or other adjustments.
Cash flows between two assignees and the Clearing Manager is shown for each option in
Figure 2 below.
5 Refer to Clause 14.47A of the Code.
NZX Ltd, 10 April 2012 10
Fig. 2 Assignment – disclosed price
1 2
Lower price secondary tradeSettlement
flows
$10/MW
$5/MW
$8/MW
ValueAcquisition
Price in registry
$10/MW
$5/MW
$5/MW
N/A
$5/MW to
Clearing Mgr
from Assignor
$3/MW from
Clearing Mgr
to holder
Ass
ign
or
ho
ldin
g
Ass
ign
ee
ho
ldin
g
Higher price secondary tradeSettlement
flows
$10/MW
$15/MW
$10/MW
ValueAcquisition
Price in registry
$10/MW
$15/MW
$13/MW
N/A
$5/MW from
Clearing Mgr
to Assignor
$3/MW to
Clearing Mgr from holder
Ass
ign
or
ho
ldin
g
Ass
ign
ee
ho
ldin
g
1
2
Payment due to clearing manager on settlement day month following trade
Payment from clearing manager on settlement day month following FTR period
Where price is disclosed, and that price is less than the FTR Acquisition Cost at auction, the
registry is updated with a lower FTR Acquisition Cost. As a result, the Clearing Manager will
receive less of a payment associated with the Acquisition Cost upon settlement than would
have been the case if the FTR was still owned by the assignor. The Clearing Manager will
invoice the assignor for the difference in the invoice for the month of the transfer—that is
payment is due around the 20th of the next month. Effectively, this can be thought of as the
assignor realising a ‘loss’ on the sale.6
Where a disclosed price is above the Acquisition Cost held on the register, the transfer
results in an increase in the Acquisition Cost. Upon settlement, the assignee will owe the
Clearing Manager more for the FTR than was the case previously with the assignor. In this
case, the assignor effectively realises a ‘gain’ upon transfer. The Clearing Manager ‘rebates’
the difference between the new, higher Acquisition Cost figure and the earlier one to the
assignor when the FTR is settled after the end of its term. While the assignor realises the
‘gain’ upon transfer, it is not paid out until after the term of the FTR.
Possible code change relating to scaling methodology
The scaling methodology prescribed in the Code may introduce some unintended
consequences.
As the methodology scales Provisional FTR Payments rather than Hedge Value, the hedging
effectiveness of an FTR depends on the purchase price where scaling is required. For
example, if an option FTR is purchased at the initial FTR auction for an amount that turns out
to be equal to the Hedge Value, then the Provisional FTR Payment would be zero and no
scaling would apply. However, the same FTR, if purchased for less at a subsequent auction,
would be subject to scaling and loss of hedging effectiveness. In other words, only ‘in the
money’ FTRs are subject to scaling.
The effect described in the previous paragraph applies to FTR Holders where the FTRs were
purchased at auction or where the transaction price was disclosed. Where an assignment
takes place without disclosure of price, or where the disclosed Assignment Price is greater
6 While the assignor can recognise a ‘loss’ upon assignment as the acquisition price is adjusted (the
assignor may need to pay an amount), the Clearing Manager employs a separate methodology to
establish FTR value for prudential security purposes.
NZX Ltd, 10 April 2012 11
than or equal to the initial FTR Acquisition Cost, then no scaling occurs and there is no
reduction in hedge effectiveness.
The Clearing Manager considers this effect may discourage disclosure of price, or actual
price, for assignments and may negatively impact secondary market liquidity.
In discussions around this issue, it became apparent that a different method of scaling may
have advantages. That is, rather than scale the positive Provisional FTR Payments and the
Side Payments Clearing Manager to FTR Holder, scale the FTR Hedge Values. The
calculation of the FTR Payment Scaling Factor would be modified to ensure the balance with
the FTR Rentals Amounts and FTR Acquisition Costs is maintained. This issue is also covered
in the FTR Manager’s draft FAP.
The FTR Manager and Clearing Manager believe that this approach has merit. The Authority
considers that such a Code change would not be minor, and thus would have to go through a
full consultation process with participants. The Authority intends to get advice on the pros
and cons of this approach compared to that provided for in the Code, and take the issue to
the LPRTG.
E. FTR Prudential Security Requirements: Problem definition
In this section of the document, begin our discussion of the requirements for the draft FTR
prudential security methodology. In our view the development of a FTR prudential security
assessment methodology should take into account the following:
• relevant provisions within the Code,
• submissions from potential FTR Participants,
• provisions of the FTR allocation plan,
• potential future developments in the FTR market,
• best practice principles, as assessed by the Clearing Manager and outlined below,
and
• the technical challenges associated with FTR prudential security assessment.
While the first two of these factors are mandatory, all factors must be recognised if a fit for
purpose, future proofed methodology is to developed.
Relevant code provisions
Key Code requirements relevant to the assessment of FTR prudential requirements include
Clauses (or sub-clauses) 14.19(da), 14.19A, 13,243, 13.244, 13.248(3), 13.251(4) and
13.251(7).
Clause 14.19 stipulates the amounts (or matters) that should be taken into account by the
Clearing Manager when assessing a participant’s overall minimum security requirements.
Specifically, Clause 14.19(da) states that this will include “the Clearing Manager's estimate of
NZX Ltd, 10 April 2012 12
an amount to be required by that payer in respect of any FTR in respect of which the payer is
named in the FTR register, calculated in accordance with the methodology approved by the
Authority under clause 14.19B”.
Therefore, the Clearing Manager must be able to value a participant’s FTR holdings as part of
its overall prudential security assessment for that participant. In relation to this, Clause
14.19A requires that:
(1) The Clearing Manager must formulate and publish a methodology for determining
the minimum level of security required from a payer in relation to a matter set out in
clause 14.19(da),
(2) The methodology formulated by the Clearing Manager under subclause (1) must
comply with the principle that the amount taken into account under clause
14.19(da) is an estimate of the value (being an amount that may be positive or
negative) of the FTR at the time that the estimate is made and the potential for that
value to change prior to settlement.”
Sub-clause 14.19(A)(2) limits the discretion of the Clearing Manager by requiring that the
FTR prudential security assessments are based on an estimated value and "the potential for
that [FTR] value to change prior to settlement."
Clause 13.243 states that “The FTR manager must not allow a person to participate in an FTR
auction unless the FTR manager is satisfied that the person meets the prudential security
requirements in Part 14.”
Therefore in order register as a FTR Participant (allowing a participant to bid in an auction),
the prudential security requirements in Part 14 must be met. The FTR manager has also
proposed other requirements to be met if a party is to successfully register as an FTR
Participant. These are detailed in the initial FTR allocation plan consultation document.
Clause 13.244 requires that:
(1) The FTR Manager must not accept a bid in an FTR auction if the FTR Manager
considers that the bid, if accepted, would cause the person making the bid to incur
an obligation for which it does not have sufficient acceptable security under Part
14,
(2) For the purposes of subclause (1), the FTR Manager must, based on information
received from the Clearing Manager, determine the maximum liability that each
person can incur in respect of its bids in the auction.
Sub-clause 13.248(3) of the Code states, with respect to the assignment of FTRs from one
FTR Participant to another that “ the FTR manager must not register an assignment in the
FTR register unless the FTR manager is satisfied that the assignee meets the prudential
security requirements in Part 14”.
Sub-clause 13.251(4) requires that the Clearing Manager must advise the FTR Manager:
(a) whether a person who has applied to participate in an FTR auction meets the
prudential security requirements in Part 14; and
NZX Ltd, 10 April 2012 13
(b) the amount of security that a person who has applied to participate in an FTR
auction has provided that exceeds that person's other obligations under Part 14.
Also sub-clause 13.251(7) requires that “the Clearing Manager must inform the FTR
manager, as soon as practicable after receiving a request from the FTR manager, whether an
assignee of an FTR meets the prudential security requirements in Part 14”.
To summarise, the Clearing Manager provides the FTR Manager with each FTR Participant’s
‘credit limit’ (the difference between security held and minimum security required) ahead of
each FTR auction. The Clearing Manager also verifies that an FTR Participant can meet the
prudential security requirements set out Part 14 during the FTR registration process, and
prior to the assignment of FTRs.
To enable the FTR Manager to calculate the liability of a participant in respect of its auction
bids, as per Clause 13.244, the Clearing Manager will also provide an estimate of the value
(on a per unit basis) of an FTR product prior them being traded at auction.
Best practice principles
The Clearing Manager has developed the following principles to govern its approach to FTR
prudential security:
• identify a robust and efficient method for determining the levels of prudential
security required for a participant to hold (and to bid on) FTRs.
• seek to protect the broader FTR market from default without discouraging entry
into the market by unreasonably burdening FTR Holders with excessive
requirements,
• seek to minimise assessment volatility and thus allow FTR Participants to efficiently
manage their prudential requirements,
• ensure that the methodology is transparent and able to be understood by FTR
Participants and potential FTR Participants, and
• align, where possible, with other prudential security requirements of the market.
We define a robust method as one that provides consistent, accurate assessments over a
range of operating scenarios such that the risk of over or under exposure is minimised. Over-
assessment which, if applied to 24 months of holdings, could significantly challenge the cash
flows of purchasers. Where inaccuracy leads to under-assessment, future corrections are
likely to have a material impact on participants in the form of sudden and unexpectedly
large calls, especially if those corrections are unexpected or apply to FTRs of multiple
vintages.
The twin goals of robustness and efficiency may mean that trade-offs between assessment
accuracy and cost must be made. This may not always follow, as complex models do not
necessarily buy increased accuracy with the increased cost.
NZX Ltd, 10 April 2012 14
Technical challenges
In the case of valuing FTRs, valuation is complicated by the fact that the instruments to be
valued:
• are settled up to 24-months in future,
• may be illiquid, and
• derive their value from congestion, capacity, power flows, overall price levels and
participant behaviour.
These factors will influence the cost and robustness of the methodology selected by the
Clearing Manager.
For reference, and to provide an indication of the variation in FTR value, the historical price
difference between Benmore and Haywards is provided in Figure 3 below.
Figure 3. Historical price difference between Benmore and Haywards.
($150)
($100)
($50)
$0
$50
$100
$150
$200
$250
$300
$350
$400
Difference OTA - BEN
Otahuhu
Benmore
OTA and BEN monthly average time weighted spot prices Oct 2007 - Feb 2012
$/M
Wh
Source: WITS
F. Current prudential security requirements
New Zealand electricity market participants currently face a diverse array of prudential
security requirements from the spot market to lines agreements, from the ASX futures
market to bi-lateral hedges. Each of these areas has its own risk environment and its own
distinct prudential security methodology. The introduction of the FTR market occurs at a
time when the foundations of the spot market methodology are under review.
The selection of an appropriate methodology for FTRs necessitates not only reference to the
FTR risk environment but also consideration of the overall market environment. Relevant
methodologies are summarised below.
NZX Ltd, 10 April 2012 15
Spot market
The prudential security requirements for spot market participants specified in Part 14 of the
Code have been implemented by the Clearing Manager by applying administrative methods
to calculate participants’ net exposure.
For the spot market, the Clearing Manager estimates the dollar value of electricity which has
traded but not settled using available price information, participant supplied bid
information, and cleared offer information from the system operator.
In addition to considering purchases and sales which have not yet settled, the Clearing
Manager also projects a net value associated with trading until seven days beyond the next
settlement day. These projections are administrative projections—they follow pre-
determined procedures—and are implemented to ensure consistency rather than accuracy.
The administrative projection methodology provides an acceptable estimation of future
exposure market exhibiting stable prices and load and generation patterns. Where volume
or prices are changing, the administrative method either under or over estimates exposure
resulting in an exposed market or an excessive prudential security burden for the
participant.
One effect of the ‘seven days beyond settlement day’ requirement is that the duration of
the security buffer varies. If a participant defaults on settlement, the Clearing Manager
would in the case of steady state prices and steady state generation, hold funds for
electricity traded plus seven days’ security. Immediately after settlement, the Clearing
Manager holds approximately 37 days’ worth of security beyond electricity traded.
In summary, the spot market prudential security requirements are based upon an
administrative assessment of an expected exposure based upon historic averages (rearward
facing). While there are no explicit requirements for Initial Margin or coverage for volatility,
the variable nature of the security buffer described above does, to some degree, serve as an
Initial Margin.
It should be noted that the prudential security requirements for the spot market are
currently undergoing a fundamental review by the Wholesale Advisory Group. As such, the
spot market methodology may be altered prior to or soon after the inception of the FTR
market.
Bilateral hedges(lodged with the Clearing Manager)
Participants who lodge hedges with the Clearing Manager under a hedge settlement
agreement are required to provide prudential security (or are relieved of the obligation to
provide security) for the same period covered by the spot market assessments. Quantities
are specified by the hedge contracts, and projected prices are administratively set in the
same manner as with the spot market assessments. Beyond the Clearing Manager’s
requirements, there may be bi-laterally agreed prudential security requirements to cover
exposure beyond the Clearing Manager’s 57-day assessment window.
NZX Ltd, 10 April 2012 16
ASX futures
In order to trade or hold futures positions on the ASX New Zealand Electricity Futures
market, participants are required to meet Initial Margin requirements and supplement the
account to meet Variation Margin requirements which result from changes in the value of
the instruments. The Initial Margin covers the clearing house from loss given default where
the price may move adversely before the clearing house can either secure additional
prudential security or liquidate the relevant positions.
Discussion
Both spot market clearing and ASX clearing can be thought of in the context of the standard
securities clearing model. In each case, the system is designed to protect the market from a
defaulting party until a safe outcome can be achieved. Prudential security for the spot
market is assessed on a ‘mid-point’ basis for the net amount of electricity consumed. That is
the Clearing Manager attempts to value the current holding (called current exposure). In
addition to posting security to cover the current holding, the participant posts an additional
amount to cover seven to 37 days of net consumption. This additional amount takes the
place of an Initial Margin and is the cushion available to protect other participants from loss
for the time it takes to exit a defaulting participant from the market. One difference is that
this ‘initial’ or ‘additional margin’ is calculated on a ‘mid-point’ basis....or a straight line
projection. In other markets, the initial or additional Margin required is calculated so as to
cover the worst case one-day movement. Should a participant default, the respective
clearing house can liquidate the defaulting party’s position.
In the ASX, participants must post prudential security for all futures held. In other words, if a
participant holds 3MW of Benmore futures for each quarter from Q3 2012 to Q3 2014, that
participant would need to maintain prudential security for 27 months worth of instruments.
This requirement encompasses the Initial Margin requirements as well as the Variation
Margins. A major shift in expectations for the South Island price, should the smelter shut
down for example, could lead to a significant margin calls for the derivative holder. This is
due not only to the potential magnitude of the ensuing price movement, but because of the
mismatch in prudential requirements between the spot and futures market. While the
purchaser of a future may have purchased the hedge to offset spot market risks, only 57
days of spot market risk is considered by the Clearing Manager at any given time.
A similar time frame mismatch will occur with FTRs. While the Clearing Manager is required
to hold an appropriate level of security for each of a participant’s FTRs, only 57 days of spot
market exposure are considered. As a result, a participant holding FTRs over a significant
period are exposed prudential security calls due to fundamental changes in expected price
differences between nodes.
G. Overall treatment of FTR prudential security
The main requirements for the Clearing Manager with respect to prudential security for
FTRs, as identified in section D are:
NZX Ltd, 10 April 2012 17
• to provide the FTR Manager with security requirements for each FTR to be
auctioned,
• to provide the FTR Manager with each FTR Participant’s ‘credit limit’ ahead of each
FTR auction,
• verification of FTR Participants’ prudential security holdings ahead of assignment (or
transfer) of FTRs and during the FTR Participant registration process, and
• ongoing prudential security assessments with respect to FTRs held by each
participant.
Under Clause 14.19A , the Clearing Manager’s FTR prudential security assessment
methodology is required to consider FTR value at the time an assessment is made, taking
into account the potential for the FTR value to change prior to settlement.
When an FTR purchaser acquires an FTR at auction, the purchaser incurs a liability for the
payment of the auction clearing price for the FTR secured. This liability is offset, at least
partially, by the current value of the FTR (an asset). The Acquisition Cost, and how the
Acquisition Cost may change as the result of an FTR Assignment, is covered in more detail in
the FTR Manager’s consultation document.
The current value of the FTR is determined by multiplying the quantity of the FTR times the
MWH Daily Settlement Price7 as established by the Clearing Manager. The draft
methodology for establishing this Daily Settlement Price is covered in section K.
Prior to auction, the Clearing Manager assesses the prudential security requirement
associated with each FTR to be auctioned. The draft methodology for this process is
discussed in Section L. FTR Participants must have sufficient prudential security lodged with
the Clearing Manager in order to submit a valid bid for an FTR to the FTR manager.
FTR Participants can lodge security up until 1000 hrs on the day of the auction. The Clearing
Manager provides a final update to the FTR manager at 1100 hrs. The FTR manager will not
process any prudential security adjustments8 by FTR Participants during the auction. Upon
notification of auction results by the FTR manager on the following day, security not
required to support winning bids will be released upon request by the Clearing Manager.
See Figure 4 below for an illustration of this timeline.
7 The Daily Settlement Price is the Clearing Manager’s assessment of the hedge value of an FTR on any
given day. The terminology is consistent with other derivative markets where clearing houses employ
margining and daily settlement. While the FTR market settles monthly along with the spot market,
the Clearing Manager has retained the industry standard term. The FTR market is cleared in a manner
somewhat similar to the futures market. 8 Including requests for withdrawal of security. The Clearing Manager will continue to receive
security, but this additional security will be available for the auction.
NZX Ltd, 10 April 2012 18
Figure 4. Synchronisation between the Clearing Manager and FTR Manager and impact on
prudential security.
Continuous
assignment
allowed
Continuous
assignment
allowed
No assignments
permitted
Prudential
availability locked
Prudentials not held
against FTR bids
made available
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11:00
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11:00
Auction bid window
Process auction
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Intra day timing for bids,
assignments and
prudential requirements
FTR MANAGER, AUCTION
& ASSIGNMENT SCHEDULE
CLEARING MANAGER PROVISION
OF PRUDENTIAL INFORMATION
Available prudential + liability per FTR
Available prudential + liability per FTR
FM advises CM allotment of prudentials
to cover all bids being processed
Available prudential includes
prudentials not alloted to FTR bids
Available prudentials refreshed to take
cleared bids into account
FM advises CM updated FTR position
and prudentials applied16:00
12:00
17:00
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12:00
17:00
07:00
16:00 Auction results published
The Clearing Manager processes the release of funds not required to cover prudential
security assessments within two business day of the request.
The Clearing Manager is required, under Part 14 of the Code, to assess prudential security at
least weekly. With the advent of FTRs, the Clearing Manager will also be required to provide
assessments to the FTR Manager two days ahead of each auction. The Clearing Manager
also has to verify to the FTR Manager (on an ad-hoc basis) that sufficient security is held by
FTR Participants prior to allowing FTR Participants to transfer FTRs. Based upon these
requirements, the Clearing Manager needs to be able to assess security on any given
business day.
The Clearing Manager anticipates FTR Participants will wish to check their security holdings
and exposure prior to applying for transfer and while preparing bidding strategies.
Additionally, FTR Participants may wish to reference the Clearing Manager’s Daily
Settlement Price values on a regular basis to assist with risk management, etc.
For these reasons, the Clearing Manager plans to calculate and make available prudential
security assessments on a daily basis via a secure website.
NZX Ltd, 10 April 2012 19
H. Experience in comparable systems It is useful to consider existing practice in markets which operate in a similar environment to
that which we expect to apply to the FTR market in New Zealand. Other jurisdictions, such
as the Eastern Interconnection (United States) and NEM (Australia) operate instruments
similar to New Zealand Financial transmission rights.
PJM
The Eastern Interconnection grid is operated by the Regional Transmission Organisation PJM
Interconnection LLC. PJM also operates a sophisticated FTR market. PJM member
organisations are required to meet credit requirements as outlined by the PJM subsidiary,
PJM Settlement, Inc.
The example of PJM is very appropriate to consider as PJM has had to consider many of the
same issues that we are now addressing as we stand up the New Zealand FTR market. PJM
has wrestled with the tension between “making market entry attractive to new participants”
while recognising that doing so “ may expose other members to the risk of defaults for
under-collateralized positions”9. In fact, PJM suffered two FTR payment defaults in late 2007
valued at nearly USD 85 million.
As a result of the defaults, PJM engaged in a lengthy process with the regulator to reform
the prudential security methodology specifically applied to FTRs to protect the market.
Currently, for certain classes of FTR Participants, PJM Settlements requires documentation
of risk governance procedures and policies, and it reviews these policies to ensure that
adequate policies and processes include:
• designated risk managers in the organisation structure,
• documented risk policy covering market, credit, and liquidity risks,
• clearly documented and limited trading authority,
• demonstration of FTR trader training,
• a risk reporting mechanism which reports throughout the organisation,
• independent reviews of trading activities, and
• periodic valuation of Mark to Market risk.
PJM also audits 20% of the participants in this category annually.
Financial requirements include a requirement for FTR Participants to meet a minimum net
worth documentation (in excess of $1M tangible) or face the requirement to post additional
collateral beyond what is required of other traders. FTR bidders are assessed for an FTR
credit limit (based on collateral or other credits) that is distinct from credit available to cover
other purchases.
FTR valuation occurs as follows:
1) A monthly historical value is calculated for each FTR path for which a bid is submitted.
The value is a weighted average of the past three calendar years' prices (weighted 50%
last year, 30% prior year, 20% two years prior).
9 PJM press release http://www.prnewswire.com/news-releases/pjm-completes-analysis-of-recent-
market-payment-default-and-announces-steps-to-mitigate-future-risk-exposure-58908777.html
NZX Ltd, 10 April 2012 20
2) The historical value is adjusted by 10% in order to provide some protection against year-
to-year changes in value. The adjustment is a reduction for positive historical values and
an increase in magnitude for negative historical values.
a) For options only, a further adjustment is made as follows: if the option is a buy and
the historical value is less than zero, it is set to zero; if the FTR is a sell and the
historical value is greater than zero, it is set to zero.
3) The adjusted historical value of each FTR is subtracted from the total price for that FTR
for each month. 10
During the clearing process for each auction or auction round, a check is done for
undiversified portfolios, and an additional credit requirement may be assessed.
The Clearing Manager considers that many of the provisions of the PJM requirements are
not applicable to the New Zealand market. Some provisions, such as the differential
participant requirements, are not accommodated under the Code. Other provisions, such as
use of historical payouts to set and adjust prudential requirements, may have greater utility
in networks with power flows which adhere to predictable patterns (as compared to the
opposing to dry winter, wet winter conditions experienced in the New Zealand markets)
AEMO
A discussion of the AEMO methodology was included in the Electricity Authority’s 2011
Proposal paper. See paragraph 3.4.179.11
Illiquid markets
Another issue is assessment and valuation of instruments in illiquid markets. In the FTR
Manager’s draft FAP, the FTR Manager proposes to auction the majority of FTRs for a
particular month at once, and then subsequently auction additional quantities as they
become available. Under this model, the Clearing Manager cannot rely on regular auctions
of each FTR type and vintage to establish a market price. FTRs are thus likely to be
categorised as low liquidity instruments. Valuation of low liquidity instruments requires
special consideration and often relies on indirect valuation methods.
Milk powder futures: A low liquidity example
NZX operates the Global Dairy Futures and Options market. It also provides clearing and
settlement for the market. The market has been characterised, especially at the outset, by
infrequent futures trading across a number of maturities. The general clearing methodology
is standard for derivative instruments. As with the trading of futures on the ASX, participants
who hold positions must maintain an Initial Margin (to cover worst case daily movement)
and must post a Variation Margin (when the instrument value moves against them).
The Initial Margin for derivative products is derived from the Standard Portfolio Analysis of
Risk (SPAN) system.12 SPAN assesses the risk of a portfolio by computing the maximum likely
10
Some additional provisions apply as well. See PJM Settlements credit note:
http://www.pjm.com/markets-and-operations/etools/oasis/~/media/documents/agreements/pjm-
credit-overview.ashx 11
http://www.ea.govt.nz/document/13334/download/search/
NZX Ltd, 10 April 2012 21
loss that could be suffered by the portfolio. The core of SPAN risk analysis is to simulate a
few scenarios based on potential market movements and then calculate the profit or loss for
individual contracts.
All open positions in each futures contract are subject to a mark-to-market process to derive
the Variation Margin. In valuing these positions, the clearing system will compare the
weighted average buy or sell price of the contract with the daily contract settlement price
(DSP). These mark-to-market values will be settled on a day to day basis. Settlement
instructions for mark-to-market profits and losses will be sent to participants on a daily
basis. The related cash settlement will occur on the morning of the next business day
following the trade day.
A key requirement of this system is the DSP. Where no trading has occurred, bids and offers
are used to determine a contract’s Daily Settlement Price. Where there have been no active
bids or offers, carrying cost is determined from Fonterra’s Global Dairy Trade auction.
Where no history is available from any other sources, or if the analyst deems it necessary,
Daily Settlement Price can be set manually at the complete discretion of the NZX risk analyst.
Additional Margin can be optionally charged to a participant in a form of either a percentage
or a fixed amount. Additional Margin will be added to the initial and Variation Margin to
derive the total Margin requirement for the participant. Circumstances in which additional
Margins will be imposed include, but are not limited to, the following:
• When the local market is closed for holidays while other international markets are
open, the Initial Margin which was supposed to cover one-day price movements
may be insufficient to cover the market risk. This is especially so when the
international market experiences volatility which may be felt when the local market
opens and leaves participants’ Margins eroded dramatically; and
• When the participant is financially weak, to cover the potentially higher credit risk.
It should be noted that there is a key difference between the risk management systems of
the ASX electricity futures market and the NZX dairy futures markets and the New Zealand
FTR market. ASX Clear and the New Zealand Clearing and Depository Corporation Limited
bear the residual risk each position—that is the risk that is not covered by the participant’s
prudential security holdings. As a result, concepts such as worst possible daily movement
and additional Margin are the norm.
In the New Zealand electricity market, the residual risk is borne by the participants
collectively. As such, administrative mechanisms and somewhat less robust cover may be
acceptable.
I. Potential approaches to FTR prudential security assessment
The Clearing Manager is required to develop and consult on a methodology for assessing
prudential security for FTRs. We have divided this task into two subtasks:
12
SPAN was developed in 1988 by Chicago Mercantile Exchange (“CME”). Since then, SPAN has
become a recognised standard for portfolio risk assessment and is used as the official margining
mechanism of over 50 exchanges, clearing houses, service bureaus and regulatory agencies.
NZX Ltd, 10 April 2012 22
• assessing security for FTRs ahead of auction to assist the FTR manager to determine
trading limits, and
• assessing FTR security requirements on an ongoing basis.
A broad range of approaches were reviewed to value FTRs for the purpose of informing FTR
prudential security assessments. Below we summarise this range. We discuss advantages
and disadvantages of each approach in the following section.
Administrative assessment (and adjustments)
For the purpose of this paper, an administrative assessment of prudential security
requirements is one which is pre-established, rigid in application, and involves no discretion
by the Clearing Manager. Additionally, we define an administrative assessment to be one
which does not seek to most closely value the FTR position but rather is focused on
consistency or some other objective.
Maximum cost to carry
Option FTRs have a minimum payoff of zero. The maximum exposure for an option FTR is
the auction price paid or the disclosed price in the secondary market. An administrative
approach would be to require option FTR Holders maintain full auction price as security.
This could be reduced as prices become known in the month ahead of settlement—that is as
the Clearing Manager calculates pro forma settlement amounts during the FTR month.
Default product value
Each FTR is assigned a default value that is used for exclusively for setting prudential security
levels. This value could be established based upon historical price differences, location
factors, rulings panel decisions, etc. The value would be static for the term of the FTR.
Use of discretion by the Clearing Manager
The Clearing Manager (or the Clearing Manager as approved by the Electricity Authority)
could apply a value at its discretion. This is utilised in other markets.
FTR value assessment – Market price
A valid market price is the value of an FTR at a point in time.
The market price can be extracted from:
• an auction price,
• a secondary trade price, and
• bid and offer information.
While a market price may seem like the ideal indicator of value, prices can be manipulated,
subject to significant movement upon trading due to liquidity issues, and infrequent. As a
result, trades are typically assessed to determine if they are ‘Price Setting Trades’ prior to
considering them for prudential security assessments.
NZX Ltd, 10 April 2012 23
Comparative price conversion
Prices of similar FTRs can be referenced in setting values. For example, an OTA – BEN FTR
can be referenced to assess value (or update an assessed value) of an SFD – BEN FTR.
In a market where reconfiguration auctions are available, any FTR pair can be traded when a
particular vintage is up for auction. Even where there is no trading in a particular FTR pair,
FTR values may be discernible from the results of the auction optimisation.
Carrying cost / Mark to Model
This approach considers the value at settlement, the probability distribution and volatility of
that value, and a discount rate.
When using a carrying cost/Mark to Model approach, the Clearing Manager estimates the
value of an FTR by reference to the future value of an underlying security or index. In the
case of FTRs, such an approach may reference:
• the locational price difference between the two FTR nodes and
• the sufficiency of the expected or calculated auction payments and rentals.
The probability distribution and volatility of the underlyings may convert to an ‘insurance
premium’.
In addition, the value of the payout also may be discounted to provide a net present value.
The locational price differences between nodes can be modelled based upon:
• Historical prices/price differences/location factors
• Stochastic modelling for prices (such as with PSR’s SPPD model)
• Modelling of prices through a dynamic model (incorporating feedback and
calibration)
• Modelling of network states (flow conditions) and resulting price differences in a
tailored model
• ASX futures prices for the relevant quarter
Initial Margin
In this consultation, for the most part, we have focused on assessing FTR prudential security
requirements by determining the current value of the FTR product. This approach does not
take into account the risk of changes in the values of an FTR prior to settlement, due to
factors that may be unknown by the market (or Clearing Manager) at the time of
assessment.
This approach is contrary to other options and futures markets, which require participants in
these markets to hold an Initial Margin (to cover the worst case daily movement in the value
of the instrument) as well as post Variation Margins (when the instrument’s value moves
against them).
NZX Ltd, 10 April 2012 24
In a similar manner to other markets, the Clearing Manager could also require FTR Holders
to provide an Initial Margin as part of their prudential security requirements. This would be
consistent with Clause 14.19A of the Code, which requires FTRs to be assessed as an “…
estimate of the value … of the FTR at the time that the estimate is made and the potential
for that value to change prior to settlement”. Possible options to evaluate an Initial Margin
include:
• by setting a percentage value that limits the Clearing Manager’s risk of under
exposure to an FTR to a specified value, acceptable to the Authority and
participants.
• assessing the most likely worst case movement in the value of an FTR over a
specified period of time. This period of time could either be the maximum time
required to satisfy a call from the Clearing Manager or the time required for the
Clearing Manager to off-load a participant’s FTRs13
.
Some indication of the relative size of an Initial Margin for FTRs can be made with reference
to ASX New Zealand Electricity Futures Initial Margin requirements.14 The Initial Margin is
assessed by the ASX clearing house based on the largest most likely movement in the price
of these futures contracts during a day. Assuming that a similar approach were taken for
FTRs, then it would be reasonable to assume that the Initial Margin would be higher given
that:
• ASX electricity futures are quarterly products. The volatility of electricity prices over
a month, the duration of FTRs, is likely to be more volatile and hence have a higher
risk,
• For FTRs the Clearing Manager has a longer period to consider when assessing the
most likely worst case movement. Therefore the risk of significant movement in
value will increase.
Unlike other options and futures markets the risk of default lies with FTR Holders rather than
the Clearing Manager. For this reason, the Clearing Manager does not require Initial Margin
to cover its own exposure. FTR Participants may be comfortable having no Initial Margin or
having an Initial Margin that covers only a portion of the risk typically covered in other
futures and options markets. When considering the need for, or level of, Initial Margin, FTR
Participants will need to weigh the benefits of a lower prudential security burden versus the
cost of socialising default risk.
The draft FTR prudential security assessment methodology is presented without a
requirement for Initial Margin. The Clearing Manager would support inclusion of Initial
Margin if supported by industry. The input from industry on this point is a key component of
the consultation.
13
Where, with reference to Code Clause 14.58(1)(e), the Clearing Manager would take procession of a
participants FTRs and sell them through the secondary FTR market. 14
See http://www.asx.com.au/data/clearing/nz_marginrates.pdf
NZX Ltd, 10 April 2012 25
NZX Ltd, 10 April 2012 26
J. Discussion of the merits of the various approaches
In this section we provide more detail on the range of options and review the pro’s and con’s of each.
Type Name Description Discussion Pros Cons Code compliant/
required
Ad
min
istr
ati
ve
ass
ess
me
nt
Maximum
cost to
carry
This method assigns the
maximum probable loss
for the instrument as
security requirement at
the start of the period and
retains that value for the
security requirement for
the duration of the life of
the FTR.
The maximum possible loss for an
instrument can be easily determined for
options (it is the auction clearing amount
or any subsequent bi-lateral trade
disclosure amount).
For obligation FTRs, the maximum
possible loss is the auction clearing
amount (or super ceding bi-lateral
disclosed trade amount) plus the assessed
maximum FTR payment obligation within
a defined confidence interval.
• Certainty of static
assessment
• Simplicity (for options)
• Low cost of operation
• Low discretion
• Prudential security
requirements will exceed,
by definition, the actual
exposure in most cases
• Upside will not be realised
until settlement and will not
be available to offset spot
market impairments
• Analysis required to set the
value for obligation FTRs
may be involved
May not be
compliant. Code
requires
prudential
security
requirements are
based on value,
not maximum
value.
Default
product
value
This method assigns a
default value for the
instrument as security
requirement at auction
and retains that value
where it is not superseded
by another method.
This method may be used where the
values remain within known ranges and
where the cost of applying an alternate
method of valuation outweighs the
benefit the reduction in security
requirements.
• Can serve as a valuation of
last resort and an
alternative to the use of
discretion
• Provides a ‘benchmark’
• Method required to set the
default value
May not be
compliant.
Discretion The Clearing Manager
overrides other means of
assessment and applies an
alternate value.
Discretion is used in other markets for the
purpose of setting a Daily Settlement Price
where, in the view of the market operator
or the clearing house, there are
insufficient inputs to utilise another
method effectively. Useful in low-liquidity
markets. Could be used in combination
with other methods, such as where the
other methods are insufficient because of
data limitations.
• Ability to manually adjust
for unanticipated
situations
• Provides an effective
means to provide
prudential security
assessments in the early
stages of a market.
• Increases likelihood of
challenging assessments
• Risk of misuse
yes
Ma
rke
t
ass
ess
m
en
t
Market
price –
Auction
price
Competitive auctions
establish values
This method hinges on the concept that a
rational investor would not pay a higher
price for an instrument than the value
received. Criteria to establish that an
• Initial auction has good
chance of developing
liquidity and Price Setting
Trades
• If not sufficiently liquid,
auction price may not
reflect asset value
• There may be extended
yes
NZX Ltd, 10 April 2012 27
auction clearing price is a valid Price
Setting Trade is applied. Auctions prices
provide our best look at market prices.
• Reconfiguration auctions
(if/when available)
provide potential for
excellent price discovery
and liquidity
• Variation auctions provide
additional opportunities
to establish market prices
time between auctions
• Clearing Manager does not
have right to non-traded
FTR pair pricing information
( including bids that were
not cleared)
• Bidding ‘error’ is possible,
setting higher ‘value’ than
can be sustained
• Potential for manipulation
needs to be understood
Market
price – bi-
lateral
secondary
trading
Bi-lateral trading prices
referenced
Assumes rational actors meet in the
market to set market price. Trades which
involve parties exhibiting market power
are normally not considered as Price
Setting Trades. Additionally, a sufficient
quantity is required so that the traders
have skin in the game...and are not
completing a small trade to achieve a
desired prudential security outcome.
• Can provide information
in between auctions
• Likely to be useful
indicator of value if the
secondary market is liquid
• Eligibility of a bi-lateral
trade as an indicator of
market value needs to be
looked at carefully...to
avoid manipulation and
considering trades which
may be simply ‘prudential’
transfers
• Clearing Manager does not
have universal right to this
information
• Prices obtained may not
reflect side deals, etc.
yes
Bid/offer
reference
Eligible bids and offers,
even if they do not clear or
match, can indicate FTR
market value.
Bids and offers can bracket market value
even where there is no trade.
• Can use bids/offers
posted on bulletin boards
or other trading venues
• Broadly accepted
methodology
• Requires access to FTR bids
and offers
• Careful eligibility tests
required to avoid
manipulation
• Clearing Manager does not
have rights to this
information
• Organised secondary
trading is not planned for
initial FTR implementation
yes
NZX Ltd, 10 April 2012 28
Mo
de
lle
d v
alu
e
Compar -
able price
conversion
Deriving an FTR value from
the established value of
another FTR.
This approach leverages mathematical or
empirical relationships between two FTRs
to enable the Clearing Manager to adjust
a number of FTRs where updated, high
quality information is available for a
reference FTR pair. Example 1: Using a
combination of ASX futures prices for Q4,
empirically derived insurance premiums,
and established FTR prices for October
and November to derive the FTR price for
December.
Example 2: Using a price ratio between
two FTR pairs (determined from auction
data) and using that ratio to impute a
value increase to an FTR pair based upon
movement in the value of the comparable
FTR. (such as WIL-BPE vs. HAY-SFD)
Probably most valuable once the market
moves beyond 2 nodes.
• Leverages high quality
price information for
broader application
• Information could be
made public, providing
participants up-to-date
value indications
• The nature of the
relationship used to
extrapolate prices can
change over time (i.e.
localised constraints or
changes in market
allocation of ‘insurance’
premiums)
• Potentially extensive effort
will be required to load and
monitor the associated
relationships to enable
automated updates
yes
Carrying
cost/ Mark
to Model
General: Deriving an FTR
value from predicted
settlement values,
discount rate (time value
of funds), and ‘insurance’
value
The technique involves modelling the
price difference between two nodes,
considering evolving transmission,
demand, and generation conditions, in the
short to medium term. Conditions such as
hydrology, outages, offer behaviour are
not predictable and are often included in
varied input set for numerous runs. The
spectrum of payouts is valued, not only
for the average expected value, but also
for option valuation.
In addition, where there is a reasonable
prospect for scaling of FTR Payments,
revenue adequacy may need to be
considered.
• Independent valuation
(may be important where
market
power/manipulation may
be an issue)
• Outcomes are constantly
adjusted as the inputs are
refined and path
dependency is played out
• Modelling of prices are
difficult, modelling of price
differences can be even
more difficult
• Maintaining an operating
models requires the
maintenance and
adjustment of numerous
input streams—and this
requires resources
• Added complexity
accompanies revenue
adequacy assessment if
adopted
yes
Sub-model: Statistical
analysis of historical prices
To be determined. One approach could be
the autoregressive moving average time
series model as used by PJM.
• Source data available (as
opposed to a variable wait
for a Price Setting Trade)
• Recognisable trends ease
communication of
findings with industry
• Historical prices resulted
from the interactions of a
different demand,
generation, and
transmission environment
• Relevant price data
Yes
NZX Ltd, 10 April 2012 29
• Will provide some feed
through of seasonality,
offer behaviour, and load
response
availability
• Known transmission and
generation upgrades are
not reflected in historical
prices
Sub-model: Persistence
forecast
This is simply the forecast employed by
the Clearing Manager for spot exposure.
• A simple persistence
forecast is used for near
term spot market
projections
• Needs to be combined with
other methods to go
beyond a few weeks
Yes
Sub-model: Use of
location factors
• • Yes
Sub-model: Stochastic
modelling to develop a set
of prices under a number
of different scenarios
The Clearing Manager would operate,
license, or contract for the operation of a
stochastic model for prices (such as with
Energy Link’s EMarket or PSR’s SPPD
models). Inputs to the model will alter as
the FTR month approaches.
http://www.psr-
inc.com.br/portal/psr/servicos/modelos_d
e_apoio_a_decisao/studio_opera/sddp/.
http://www.energylink.co.nz/analysis-
planning/market-models
• Future grid, generation,
and demand
configurations can be
incorporated.
• Significant events, such as
a major HVDC outage, can
be rapidly incorporated
into assessments
• Industry standard models,
while they are simply
models, have gained
industry acceptance for
what they do.
• There is flexibility around
control of the models
employed: Clearing
Manager operated,
Electricity Authority
Operated, consultancy
operated, etc.
• Model results may be
provided to industry to
aid in transparency,
planning, etc.
• Intensity of effort and cost
• Care must be taken around
dispatch blocks—some
models operate in fairly
aggregated blocks which
may obscure HVDC transfer
switching and limit utility
for valuing options.
• Reliability depends on
underlying accuracy of
model
Yes
Sub-model: reference ASX
futures prices for the
relevant quarter
The Clearing Manager would subscribe to
ASX data and track movements in the
differential between OTA and BEN futures.
ASX future prices can be utilised in two
ways.
• An industry recognised,
and improving, forward
price curve (some debate
this)
• Potential for alignment of
• Quarterly term limits direct
utility for FTRs – requires
significant analysis to break
price signal into constituent
parts.
NZX Ltd, 10 April 2012 30
1. Movements in ASX future prices could
be projected onto movements of FTR
prices. For example, if OCT 2014 BEN-
HAY obligation FTR auctions for $7000
(MWxmonth), at a time when HAY
less BEN for ASX Q4 14 is $8, then if in
two weeks time, HAY less BEN for ASX
Q4 14 moves to $7, the Clearing
Manager may assess the new value at
$6125 and the holder of the FTR
would be called for $875/MW.
2. ASX future price differences may be
applied directly to quarters, ignoring
expected price differential between
months. For example, if OCT 2014
BEN-HAY would be valued at
$5952/mw, at a time when HAY less
BEN for ASX Q4 14 is $8. [$8mwh x 24
hr x 31 days]. Alternately, a price
profile can be applied to ASX prices to
break out monthly differentials.
FTR prudential security
obligations and ASX
prudential security
obligations, which would
enable some participants
to manage exposure
across markets (manually)
• Option for Clearing
Manager or FTR manager
to bundle three FTR
months (e.g. OCT, NOV,
DEC 2014) into ‘strips’
which mirror ASX quarters
and then allow direct use
of ASX prices for
prudential security
calculations .
• Trading limited to BEN-OTA
which limits direct
application to other FTR
pairs.
• If market liquidity is
marginal, may require ‘Price
Setting Trade’ testing
• Participants to trades not
transparent so Clearing
Manager blind to market
power/manipulation
implications
• FTRs are settled against
each trading period
individually rather than the
average difference for the
month.
NZX Ltd, 10 April 2012 31
K. Draft methodology for on-going assessment of FTRs
This following outlines how the Clearing Manager intends to assess participants’ FTR
holdings on an on-going basis.
The methodology considers each FTR Participant’s FTR holdings as identified in the registry
and multiplies the associated MWh FTR quantity by an assessed FTR Daily Settlement Price
to arrive at the participant’s total Hedge Value. The Clearing Manager then considers the
Acquisition Cost owed to arrive at the net FTR exposure. The Clearing Manager
determination of the Daily Settlement Price is the defining aspect of the methodology.
A key feature of our draft methodology is the employment of one of a handful of distinct
valuation sub-routines depending on the information available and proximity to settlement.
While the methodology’s business rules which are applied to determine which sub-method
to use may be somewhat involved, the overall methodology should appear simple to the
casual observer. The Daily Settlement Price provides a single metric of Hedge Value.
The methodology can be applied to either options or obligations and can be applied to any
variety of FTR nodes.
The draft methodology will operate from 24 months ahead of the FTR month until
settlement. During this time, different assessments apply for each of six periods. These six
periods include:
• the period after the FTR month but ahead of settlement,
• the FTR month,
• the month prior to the FTR month, and
• three other periods extending to 24 months ahead.
During each of these periods, distinct sets of business rules are applied to derive a preferred
valuation method. The distinct periods were created in recognition of the fact that the most
appropriate methodologies for determining value are time dependant. For example, the
Clearing Manager has Final Prices after the FTR month, so interim or final pricing can be
relied upon exclusively.
For each of the periods, the Clearing Manager utilises one of a combination of five sub-
methods. The pre-determined choice of sub method reflects information availability and
suitability. The best source of information is sought first. Where that quality of information
is not available or current, the next best source is sought. The sub methods are:
• Actual underlying price (spot price),
• Projected underlying price (from Clearing Manager spot market prudential security
assessment methodology)15,
15
While it certainly can be argued that the Clearing Manager’s price projection methodology is far
from best-in-class—it is a simple persistence model based on a profiled, trailing three week average—
it was chosen as the preferred near settlement forecast as it is used to support spot market
NZX Ltd, 10 April 2012 32
• Market value of the FTR as determined by a Price Setting Trade,
• Adjusted Daily Settlement Price based upon bids and offers,
• Adjusted (or drifted) market value determined with reference to:
o A price or price difference forecast model, and/or
o ASX futures prices
Figure 5 shows how different valuation rules are applied in each of the six periods. The
application of sub-methods is changed over time to take advantage of the best available
information.
Figure 5. Progression of methodologies for setting the Daily Settlement Price
Funds
received
(settlement)
FTR Month
Months
ahead of
FTR month12345678 091
0
1
1
1
2
1
3
1
4
1
5
1
6
1
7
1
8
1
9
2
0
2
1
2
2
2
3
Actual prices / settlement amounts
Spot Market Persistence Forecast
PST within 7d or ASX modified PST
PST within 14d or ASX modified PST
PST within 30d or ASX modified PST
Initial
Auction
Price setting
trades
Fig. 1 Combined methodologies for setting Daily Settlement Price
DSP Method Methods
phased in
over month
In the illustration, colours represent the relative quality of assessment. They roughly equate
to the three tiers in the standard hierarchy used to establish fair value for securities and
derivative assets. The first tier (green above) relate to values derived from observable
prices in highly liquid over-the-counter markets or exchanges. The green areas toward the
right also relate to values derived directly for high-confidence underlyings—Final Prices.
Green represents the highest quality assessment of FTR value.
The second tier (not shown above) would include indicative quotes or data gathered from
disparate markets or brokers. If bid and offer details for secondary trading become
available, the clearing manner would include these values in the methodology. The Clearing
Manager does not expect this information to be available in the near future.
prudential security assessments. Participants who have FTR positions, a hedge lodged with the
Clearing Manager, and an offsetting spot market exposure will benefit from netting and will not suffer
any basis risk from divergent price forecasts.
NZX Ltd, 10 April 2012 33
The third tier involves principles-based valuation which is shown above in red. This colour
represents the least reliable of the three tiers. Methods for these tiers are applied where
one may reasonably expect that the impact of time or market events have degraded the
quality of a valuation derived from a higher tier source.
As valuations from higher tiers are more reliable, accuracy can be improved by holding
additional auctions, providing opportunities for increased secondary trading, enhanced
disclosure of secondary trading, and efficient models.
The table below elaborates on the methods illustrated in the figure above. A feature of the
draft methodology is the presence of successively shorter timeframes for which the Clearing
Manager references the previous trade price. This progression reflects the fact that closer
to settlement, higher quality information is available and that information is updated on a
regular basis.
Time Primary method If primary unavailable
Prior to settlement/after FTR month Calculated settlement amount Estimated settlement
amount
During FTR month Partial: Calc settlement
amount
Partial: Spot market
prudential security spot
market price estimates
Month Prior to FTR month Phased in: Spot market
prudential security spot
market price estimates
Phased out: Price Setting
Trade (or equivalent) within 7
days where no material
events have transpired
Phased in: N/A
Phased out:
Price referenced to FTR
bids and offers.
Where this information is
not available then price
will be adjusted with
reference to ASX futures
and a price forecast model.
> 1 month prior and < 5 Months prior Price Setting Trade (or
equivalent) within 7 days
where no material events
have transpired
Price referenced to FTR
bids and offers.
Where this information is
not available then price
will be adjusted with
reference to ASX futures
and a price forecast model.
> 4 months and < 13 months Price Setting Trade within 14
days where no material
events have transpired
Price referenced to FTR
bids and offers.
Where this information is
not available then price
will be adjusted with
reference to ASX futures
and a price forecast model.
From 13 to 24 months ahead Price Setting Trade within 30
days where no material
events have transpired
Price referenced to FTR
bids and offers.
Where this information is
not available then price
will be adjusted with
reference to ASX futures
and a price forecast model.
NZX Ltd, 10 April 2012 34
Criteria for assessing if market based prices can be used to assess value
The draft methodology also considers a number of considerations in evaluating whether or
not to use a market based price to assess value.
• Price Setting Trade: A trade is not considered a Price Setting Trade unless at a
minimum, it involves the lesser of 2 MW capacity or a trade value of $100016.
Trades are considered to establish value where a reasonable investor puts value at
risk. Low value trades do not support this assumption.
• Related parties: Trades between established related parties may be omitted from
consideration.
• Trades where participants exhibit market power: Trades where the Authority
advises one party holds significant market power may be exclude at the request of
the Authority17.
• Trades intended to manipulate prudential security levels: Trades where the
Authority advises it holds a reasonable belief that the trade is an intended to
manipulate prudential security levels may be exclude at the request of the
Authority.
Predictive model
The draft methodology includes the use of a price or price difference forecast model, based
on one of the methods described in Section I, to assist with prudential security assessment.
A model will be used where no better information is available and as means of adjusting a
Daily Settlement Price to reflect changed market pressures (applying drift). While details
have not been confirmed, security assessments for such purposes could be based on a
weighted average of prices determined from a model and prices determined with reference
to ASX futures. The weighting could depend on the quality of ASX price information and the
FTR to which the assessment was being applied to (e.g. a weighting in favour of the model
would apply where there is no ‘Price Setting Trade’ or for an FTR pair where the HVDC is not
very relevant). There would also be the intent to adjust the weighting as experience with the
methodology develops.
The inclusion of a model, rather than strict reliance on ASX forward prices, provides a
methodology to disaggregate quarterly price information into more discrete components. It
also provides the opportunity to independently monitor security assessments as a check
16
The $1000 threshold for value at risk is based on amounts applied in other markets in the Clearing
Manager’s experience. Occasionally, FTRs, especially out of the money options, may trade at modest
prices. In this case, the Clearing Manager proposes that a trade of 2 MW could be consider price
setting. 17
The Clearing Manager considers this role fits naturally with the Authority’s market monitoring
function. Furthermore, the Authority will have a broader view of participants overall position, where
as the Clearing Manager will only have a view of some parts of a participant’s portfolio.
NZX Ltd, 10 April 2012 35
against FTR prices that do not adequately reflect market value. It also protects against the
loss of access to ASX information.
L. Draft methodology for initial auction of FTRs The following outlines how the Clearing Manager intends to provide the FTR manager with a
value for an FTR which has yet to be traded at auction. This methodology is a special case of
the methodology to assess FTRs holdings on an on-going basis, as described above.
It may be argued that the initial FTR auction for each vintage will provide the most liquid
trading to establish price. It may also be argued that the bidding participants have the least
information available at that auction and that the bidders who err most in their valuation
will win.
Our draft methodology for determining initial auction prudential security requirements is as
follows:
• the FTR value is the lesser of:
o the auction clearing price or
o the FTR Reserve Value
• the FTR Reserve Value is as determined by the draft methodology described above
multiplied by a factor of 1.5, however
• For the first three auctions and for any auction for an instrument 12 or more months
prior to settlement, the FTR Reserve Value shall be the lesser of:
o the six year average settlement value (back casted) times a factor of two for
obligation FTRs and half the auction clearing price for option FTRs, or
o the value obtained by applying the principle of ‘drift’ to the most recently
traded FTR in a proximate vintage, times a factor of two
The application of factors is intended to allow the market to set the new value of the units at
auction while restricting large swings in value which are not supportable by available
information.
The draft methodology for consultation is included in the box below. The Clearing Manager
invites comments and suggestions on this methodology.
Spot, lodged hedge, and FTR exposure assessment
The Clearing Manager assesses prudential security requirements for participants or FTR
Participants as being the net of:
- Spot market exposure as described in the Clearing Manager’s functional specification,
- Exposure for hedges lodged with the Clearing Manager (assessed for the same period as
the spot market exposure), and
- Exposure to FTRs
NZX Ltd, 10 April 2012 36
A participant’s exposure to FTRs holdings is assessed as the net value of all FTRs held on the
FTR registry. Lodged hedges and spot market exposures are assessed for a period of
approximately 57 days inclusive of current and projected exposure.
Prudential assessments and balances are updated each business day by 11 am to reflect
updated information and participant actions. Participants will be able to view balances by
secure web portal.
FTR exposure calculation
Principles
The adopted methodology shall
• be applicable to multiple hubs as well as the initial Benmore-Haywards pair,
• respond to changing market inputs, and
• avoid introducing ‘methodology-driven’ volatility into the assessment process.
Definition
For the purpose of assessing exposure to each FTR held by the participant, exposure is
defined as:
FTR Hedge Value – FTR Acquisition Cost.
FTR value determination
The FTR value for the purposes of prudential security is the Daily Settlement Price (DSP)
calculated by the Clearing Manager multiplied by the FTR quantity.
The DSP is calculated for each FTR product on the registry. This value will be available from
the Clearing Manager’s website.
For the period prior to one month ahead of the FTR period, the DSP for each product is
calculated as follows:
1. The DSP shall be equal to a Price Setting Trade price where that trade occurred within the
following timelines:
> 1 month prior and < 5 Months prior to the FTR period – within seven days of assessment
> 5 month prior and < 13 Months prior to the FTR period – within 14 days of assessment
> 13 month prior to the FTR period – within 30 days of assessment
2. Where a Price Setting Trade which meets the requirements of the above paragraph is not
available, the FTR value is to be set according to the following formula:
DSP = previous DSP x %change in Reference Price between the date the previous DSP was
first established and the assessment date.
This formula is subject to modification upon review subsequent to approval by the
Authority.
NZX Ltd, 10 April 2012 37
A Price Setting Trade is a trade which is deemed, by the Clearing Manager, to reflect a
market price. Initially, a Price Setting Trade will involve a transaction value greater than
$1000 or transaction quantity greater than 2MW.
The Clearing Manager calculates a Reference Price for each FTR product. The Clearing
Manager develops and maintains Reference Price methodologies. Reference Prices are not
published; however the resulting DSP values are published.
For obligation FTRs, the Reference Price is derived from a weighted average of a predictive
price model and the ASX New Zealand Electricity futures price, adjusted to compensate for
basis difference (period and location). The weighting of the components may vary (and may
be set to zero. )
For option FTRs, the Reference Price is derived from applying an option valuation model to
the results of an appropriate predictive price model.
For the month ahead of the FTR period, the above DSP methodology is phased out and a
calculated FTR settlement based upon the Clearing Manager’s spot market prudential
security price projection methodology is phased in. This ensures alignment spot exposures,
lodged hedges and near term FTRs are assessed on the same measure and will offset
appropriately. The phase in is used to avoid step changes in security requirements.
For the FTR period, calculated FTR settlement value is used. Actual prices are used where
available – otherwise the projected prices are used per the spot market methodology.
After the FTR period and prior to settlement, calculated FTR settlement value is used.
Initial prudential security requirements to be met before bidding
This initial prudential security methodology is a special case of the methodology to assess
FTRs holdings on an on-going basis described above.
The initial FTR prudential security value is the lesser of:
- the auction clearing price
or
- the FTR Reserve Value.
For the first three auctions and for any auction for an instrument 12 or more months prior to
settlement, the Reserve Value shall be the lesser of:
- the six year average settlement value times a factor of 2 will be used for obligation FTRs
and half the clearing price for option FTRs will be used or
- the value obtained by applying the principle of ‘drift’ to the most recently traded FTR in a
proximate vintage, times a factor of 2.
For other auctions, the FTR Reserve Value is determined by the Daily Settlement Price
methodology described above multiplied by a factor of 1.5.
NZX Ltd, 10 April 2012 38
The application of factors is intended to allow the market to set the new value of the units at
auction while restricting large swings in value which are not supportable by available
information.
M. Refinement of the draft methodology
The Clearing Manager will continue to study aspects related to the draft methodology during
the consultation period. Specifically, the Clearing Manager has set up a modelling
environment to enable modelling and back casting of specific sub-methodologies. The
modelling and back casting is intended to validate the function of the sub-methodologies
and establish the range of FTR valuations. Findings, as available, will be presented at the
industry workshop in May.
One main decision for the draft methodology is the selection of an appropriate forecast
model. The Clearing Manager is seeking advice from the industry on the draft methodology
during the consultation period before intensively investigating models. The Clearing
Manager proposes to select an appropriate model in consultation with the Electricity
Authority and the WAG. The Clearing Manager plans to communicate model selection and
provide analysis of subsequent back casting to the industry when available.
Further detailed design work to be completed after the close of the consultation period
includes:
• setting of weightings (e.g. % ASX derived price movement vs. % model-based price
movement),
• refinement of parameter details for sub-methodologies,
• refinement of boundaries between sub-methodologies,
• the method for converting ASX price drift to FTR price drift, and
• the inclusion of any feedback or calibrating mechanisms.
Once the methodology parameters are set (except as adjusted by feedback mechanisms),
the methodologies will be fixed and disclosed to ensure transparency.
FTR trade frequency
All else being equal, increased frequency of secondary FTR trading, or distributing initial
sales across a number of auctions will increase high-quality price discovery and reduce the
Clearing Manager’s dependence on estimates. As such, the Clearing Manager recommends
the Authority and the FTR manager consider frequent auctions.
While high liquidity is predicted with the OTA-BEN FTR pair, liquidity for subsequent FTR
pairs may be substantially less. The provision of re-configuration auctions, where
participants can offer FTRs back into the capacity pool, will assist in ensuring that secondary
market FTR trades are Price Setting Trades. The Clearing Manager recommends that the
Authority and the FTR manager consider implementation of reconfiguration auctions upon
commencement of trading of additional FTR pairs.
With sufficient FTR trading/disclosure, the Clearing Manager may assess the merits of de-
commissioning some aspects of the draft methodology. In other words, as the quality of
NZX Ltd, 10 April 2012 39
market information improves, trade information may be sufficient to eliminate the need for
modelling or reliance on ASX information. Any changes will be consulted upon with
industry.
N. Consultation questions
The Clearing Manager would like participants to provide feedback on the following
questions:
a. Does the draft methodology provide a means to appropriately value FTRs for
prudential security purposes?
b. Do you support a requirement for Initial Margins? If so, do you support assessment
of Initial Margin to the extent applied in other futures markets or do you support a
lesser requirement?
c. If you do not support Initial Margins but were required to post Initial Margins to
participate in the FTR market, what characteristics would you like to see
incorporated in a methodology to determine Initial Margins?
d. Do you support the use the spot market prudential security methodology for
projecting price in valuing FTRs where indicated in the methodology or is the
application of a more sophisticated approach preferred?
e. The Clearing Manager is evaluating models for developing a price forecast which has
sufficient resolution to evaluate nodal price differentials with intra-day flow
reversals. Do you have preferred models or modelling approaches?
f. What information can assist your organisation to assess FTR trading opportunities
and risks?
g. What if any of the prudential security requirements or assessment methods applied
by other markets should be applied in New Zealand, regardless of compatibility with
the Code?
h. Do you support removing reference to a model and utilising a simpler assessment
method if it requires assessment of an Initial Margin for obligation FTRs and posting
of the entire Acquisition Cost for option FTRs?
i. Is the proposed flow of information sufficient to support participation in the
market?